Question #50504

Sita expects her future earnings to be worth Rs. 100. If she falls ill, her expected future earning will be Rs. 25. There is a belief that she may fall ill with probability of of remaining in good health is while the probability Let her utility function be given as U(y) = suppose that an insurance company offers to fully insure Sita against loss of earnings caused by illness against an actuarially fair premium. (a) Will Sita accept the insurance? Explain. (b) What is the maximum amount that Sita would pay for the insurance?

Expert's answer

Future earnings - Rs. 100.

If she falls ill - Rs. 25.

(a) As there is not enough data to answer the questions (probabilities and utility functions are not provided) Sita may accept the insurance, if the probability of illness is too high and the insurance payment is affordable. (b) The maximum amount that Sita would pay for the insurance can be calculated according to probabilities, which are mentioned, but not provided. But this maximum amount will be less than 100 - 25 = Rs. 75.

If she falls ill - Rs. 25.

(a) As there is not enough data to answer the questions (probabilities and utility functions are not provided) Sita may accept the insurance, if the probability of illness is too high and the insurance payment is affordable. (b) The maximum amount that Sita would pay for the insurance can be calculated according to probabilities, which are mentioned, but not provided. But this maximum amount will be less than 100 - 25 = Rs. 75.

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